Gold News

London Gold "Fix" No More

Too old to get any respect, the London Gold Fix is set to change...
 
The GOLD FIX is a centre-piece of the London bullion market, heart of the world's precious metal trade, writes Adrian Ash at BullionVault.
 
The current Gold Fixing process is not broken. In fact, its 100 years of continuous use prove the Fix is exceptionally fit for purpose. 
 
But perceptions of the Fix have been tarnished. And with the new London Silver Price process set to start on 15 August, it was only a matter of time before the Gold Fix moved to review and reform as well.
 
Now the Gold Fixing Ltd – a private limited business which exists solely for its four member banks to meet by phone and discover the single price which clears the most business in physical gold at 10.30am and 3pm each working day – says it wants to reform the way the Fix works, and has invited proposals for administering the process.
 
Good. Perhaps we can all move on to more important stuff soon. I guess it's unlikely to be called the "Fix" anymore. At a minimum (and here's hoping), replacing the human chairman with an algorithm, and the telephone with an electronic platform looks certain. Beyond that, the critical point – as the new Silver Price process intends – is to retain the deep liquidity the Fix offers to buyers and sellers worldwide, and to assure all parties that the process for identifying the single price which clears the maximum volume of business is based on genuine dealing.
 
How to find a new system over a century after the current process was born? Selection of the new Silver Price process was robust and thorough, with the London Bullion Market Association polling both its members' and the broader market's views, and then inviting proposals in line with those findings. Seven pitches came back, and LBMA members were again asked for their views.
 
Crucially, the chosen solution...a joint bid from securities exchange CME and data providers Thomson Reuters...drew the largest number of potential market makers. That ensures the deepest liquidity for what has been, in the form of the London Fixes, a dealing point first and foremost and a "benchmark" post hoc. 
 
Now, like the Silver Fix (1897-2014), the Gold Fix...as your newspaper will no doubt tell you tomorrow morning...has become the "benchmark price" for gold worldwide ever since a group of bankers met at N.M.Rothschild's offices in 1919 to "fix" the price. (Actually 1907 or earlier, but nevermind.) First because London is the centre of the world's wholesale bullion market. Second, because at no other time of day is there a single, market-wide price for physical metal.
 
You see, gold and silver trade what is known as "over the counter" (or OTC for short). I's a principal-to-principal market...not a centralized exchange point for standardized contracts like the stock market. Each buyer and his/her seller agree a unique price between them for their unique deal. The only standardized thing in this "spot" market is the quality of the metal involved, set and warranted by the world-leading London Good Delivery rules.
 
So far, so beautiful. Each participant can take or make prices as they choose. Each must also know and judge the credit risk and business balancesheet of their counterparty (settlement terms are typically two days). There is individual, not centralized risk, and the business is done under Sale of Goods law, rather than financial services regulation. Because we're talking about a lump of metal, not a credit or securitized asset.
 
Still, for the world's wholesale bullion industry, this series of private one-to-one deals leaves three issues:
  • What if I want to buy or sell more than one single counterparty can trade at one price in one go?
  • Which quote from the hundreds of different dealer and bullion banks most nearly represents "the market price" on any given day?
  • How do I...as a miner, central bank, jeweller or investment fund...then value my outstanding holdings?
Step forward the Gold Fix. Here, at 10.30am and 3pm London time, a group of bullion bank dealers get together to pool their resources (wholesale clients are invited to deal any size) and find the one, single price which clears the greatest volume of business on their books at that moment. That price is then referenced, after the fact, by investors and industry as the price for that day.
 
The Silver Fix does just the same. Again, the process can take a few minutes as new prices are tried and new orders respond. Because again, the outcome is the single price which clears the most business. But whatever its advantages to the market, the Silver Fix is now set to end in mid-August. Because with Deutsche Bank resigning its seat, that leaves only two banks to pool their resources and find that single, market-wide price. Such a proposition is untenable. And with a new London Silver Price process set to start on 15 August, the four member banks on the Gold Fix (which Deutsche has also quit) have decided to review and reform their daily offer to the world's bullion market.
 
There's plenty of other pressure for change. First, the process is old. Again, we think that proves its success, but assisted dying is all the rage, if not yet euthanasia. So outside those professionals actually using the market (a survey of more than 440 bullion-market participants found that 72% were perfectly happy with the existing daily silver price), the Fixes look "out dated" – and yes, the cult of youth now extends even to ageless, incorruptible gold.
 
The Fix also involves a small group of banks sharing information with each other...and saying whether at any given price their order book is a net buyer or seller. That suggested price is then raised or lowered to bring out buying or selling to match from across the members' books. Unenquiring minds think this smacks of collusion. They also mistake the fact that Fixing customers can listen into the call and change their orders as the price is moved up or down for some kind of horror story. Whereas it is in fact it is vital to finding the one price which does the most business. Those customers can also change their orders in other, related markets too of course. Because they must have the ability to deal elsewhere if the Fixing price is to stay competitive and win their business. But again, this vital feature is somehow a "bad thing" in the court of what passes for public opinion.
 
The Fix also stands accused of being gamed by crooked traders. Certainly, one tried it – and so lost any hope of ever working in finance again. Other instances may well turn up, but that 2012 case in fact proved that the Fix itself works as required. It was the trader placing orders into the Fix who was bent. How might changing the Fix change human behavior? Sanctions already exist against scamming clients and making false markets in the way that ex-Barclays trader Daniel Plunkett did. Proper record-keeping and reviews look helpful, as the UK regulator demanded of Barclays when fining it – rightly – for a lack of internal controls. The Fixing process, on the regulator's report, was in no way at fault
 
However, several researchers from outside the market say that price movements in gold futures, gold ETF derivatives, or averaged OTC "spot" quotes look suspicious before, during and after the Fix. That suggests collusion between the banks. Apparently.
 
NB: The two most-cited studies have not yet – to the best of Jstor's or Google's or our knowledge – been published. So they don't appear to have been independently peer-reviewed. Like the one paper which has been published, both seem to claim there is something unusual about the way gold prices in related markets move around the time of the Fixings. Quite what "unusual" means we can't imagine. But the claim surely rests on three assumptions. First, that there is some kind of "normal" movement in asset prices, against which the Fixing activity looks "abnormal". Second, that information about the suggested price moving up or down leaks into other, related markets, but it "should not". And third, that the sheer size of the business being done at the Fix...a moment of uniquely deep liquidity, pooled across several big institutions...shouldn't count at all with regards to where the single price enabling the greatest volume of business is then found.
 
But price movement around the Fix must be expected. Because price is always a function of size...and the Fixes offer the deepest single dealing points in the trading day. Just as important, and from what direct participants tell us, client business tends to be all one-way on any given day. In other words, the bulk of people tapping the liquidity offered by the Fixing member banks will all want to sell or want to buy together. That leaves the member banks – pooling their liquidity to deal any size, and seeking an economic profit in competition with those other, related markets – to buy/offer what is wanted. If all the customers are selling (or buying), then the price must be moved down (or up) to either deter some of the supply (or demand), to attract opposite orders from other customers, to incentivize the banks themselves to match client trades off their own "house" book, or all three at once. The market only balances – and all those sellers (or buyers) only get to sell (or buy) – when the price moves down (or up) enough to bring out buyers (or sellers) on the other side.

Does anyone outside an election manifesto or North Korea really propose markets should work some other way? Remember: no one forces anyone to trade at the Fix. Clients can withdraw orders and place them elsewhere if they choose. The bullion banks making the market are not a public service. But where they find they must make one side of the market entirely, and do all the buying (or selling) to match the one-way traffic from Fixing clients, they risk losing that day's Fixing business if they bid too low (or offer too high). Because customers will simply go elsewhere, to Comex futures, the big ETF trust funds, or OTC spot with another dealer.

 
No, I haven't attended a Fixing call, but BullionVault is a regular end-user of the Fix, placing orders to buy and occasionally sell at these events three or four times a week. So the member banks' order book will include our trades, placed via the dealers we use who do attend the call. And like 72% of the professional wholesale market, we're perfectly happy with how the wrinkly old Gold and Silver Fixes work, and what they do. The current Fixes are a vital part of London's bullion services to the world. So like the new London Silver Price starting next month, the Gold Fix's replacement...or reform...must continue to offer deep liquidity first.
 
Only then can the price it spits out be taken as the world's single-price "benchmark" for business that was done, that day, in volume.

Adrian Ash is director of research at BullionVault, the world-leading physical gold, silver and platinum market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and he has now been researching and writing daily analysis of precious metals and the wider financial markets for over 20 years. A frequent guest on BBC radio and television, Adrian is regularly quoted by the Financial Times, MarketWatch and many other respected news outlets, and his views from inside the bullion market have been sought by the Economist magazine, CNBC, Bloomberg, Germany's Handelsblatt and FAZ, plus Italy's Il Sole 24 Ore.

See the full archive of Adrian Ash articles on GoldNews.

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